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Copyright © 2009 John Wiley & Sons, Inc.

C H A P T E R3C H A P T E R3C H A P T E R3C H A P T E R3TheTheTheThe IncomeIncomeIncomeIncome StatementStatementStatementStatement

OVERVIEW

Businesses want to be profitable and as a professional hospitality manager or owner, youwill want to operate a profitable business. The vehicle businesses use to document andreport their profits is called the income statement. In the past, some managers have referredto the income statement as the ‘‘Profit and Loss’’ (P&L) statement and as a result that namefor it is still used by some in the hospitality industry. In this book we will simply refer tothe document by its shortened name: the Income Statement.

A business’s revenue minus its expenses equals its profits. The income statementreports in detail and for a very specific time period, a business’s revenue from all itsrevenue-producing sources, the expenses required to generate those revenues, and theresulting profits or losses (net income).

In this chapter you will learn why the income statement is so important to all those whowill typically review and analyze it. You will also see why it is so critical for the manager whois actually operating the business to be able to read and correctly analyze and interpret theincome statement. Perhaps most important, in this chapter you will learn how managersread and analyze their income statements to learn as much as possible about the currentand future profitability of their businesses.

63Copyright © 2009 John Wiley & Sons, Inc.

64 CHAPTER 3 The Income Statement

CHAPTER OUTLINE

� The Purpose of the Income Statement� Income Statement Preparation� Income Statement Analysis� Apply What You Have Learned� Key Terms and Concepts� Test Your Skills

LEARNING OUTCOMES

At the conclusion of this chapter, you will be able to:

✓ State the purpose of regularly preparing an income statement for a hospitality business.✓ Explain the way managers and accountants actually prepare an income statement.✓ Analyze an income statement to improve the operation of your own business.

The Purpose of the Income StatementWhen you manage a hospitality facility, you will receive revenue, the term used to indicatethe money you take in, and you will incur expenses, the cost of the items required to operatethe business. The dollars that remain after all expenses have been paid represent your profit.For the purposes of this book, the authors will use the following terms interchangeably:revenues and sales; expenses and (in most cases) costs; profit and income.

The following is the basic profit formula used in the hospitality industry and it is alsothe format followed when preparing the income statement.

Revenue − Expenses = Profit

To illustrate the formula, consider Paige Vincent, the general manager of the BlueLagoon Water Park. Paige’s water park will generate revenue from a variety of sources.These revenue sources include:

Room sales (including water park admission)In-room sales of movies and gamesTelephone toll chargesMeeting room rentals


The Purpose of the Income Statement 65

Gift shop salesRestaurantLounge/BarSnack barVideo/arcade games

In addition to generating revenue, Paige will, of course, generate expenses and incurcosts as she operates each of these major revenue centers. Her goal should be to generate aprofit in each of the revenue centers she manages. In fact, many hospitality managers calleach individual revenue generating segment within their business a profit center.

The revenue − expense = profit formula holds even in what is not typically considereda for-profit segment of the hospitality industry. For example, consider the situation ofHector Bentevina. Hector is the manager of the Blue Lagoon’s employee cafeteria. Hectorsupplies no-cost (to the employees) meals to the park’s large group of service workersand managerial staff. In this situation, the water park clearly does not have immediate‘‘profit’’ as its primary motive in operating the cafeteria. In fact, in many business diningsituations, food is provided as a service to the company’s employees either as a no-cost (tothe employee) benefit or at a greatly reduced price. In some cases, executive dining roomsmay even be operated for the convenience of management. Thus, it is common in manysituations to operate a cost center that generates costs but no revenue. In cases such asthese, management’s goal may be to maintain or achieve a predetermined cost for operatingthe center. Whether they are operating a profit center or a cost center, however, hospitalitymanagers must know as much as they can about how their revenues and expenses aregenerated if they are to maximize their revenues and control their costs. Thus, if Paige isto operate the most successful water park she possibly can, she must fully understand therevenue and expense generation in all of her profit (and cost) centers.

Managers are not the only ones interested in a business’s revenue, expenses, and profits.All stakeholders who are affected by a business’s profitability will care greatly about theeffective operation of a hospitality business. These stakeholders may include:

� Owners� Investors� Lenders� Creditors� Managers

Truly, the owners, managers, and employees of a hospitality business all benefit mostwhen that business is successful. As a result, when an accurate income statement is used toprovide information, the business’s owners, lenders, investors, and managers can all makebetter decisions about how best to develop and operate it.

Owners

The owners of a business typically have the greatest interest in its success. In manycompanies, however, the owners do not actively participate in the management of the



business. For example, in the case of Paige Vincent and the Blue Lagoon Water Park, Paigeserves as the general manager (GM) of the park. She is employed by Synergy Promotions,the park’s owners. These owners represent themselves and the park’s investors and lenders.As a result, Synergy Promotions employs Paige and sets general policies, procedures, andgoals for her. Actual day-to-day operations of the park are left to Paige and her managementteam. In many cases, owners of a business would be unable to exercise close control becausethey are physically removed from the business. By evaluating the data in the Blue Lagoon’sincome statement, those responsible for managing Synergy Promotions will better be ableto determine the effectiveness of the manager they have selected and the progress madetoward goal achievement.

Investors

Investors supply funds to restaurants and hotels to earn money on their investment. Theseearnings generally include periodic cash payments from profits generated by the business,plus any property appreciation (increase in value) achieved during the period of theinvestment. Restaurants, hotels, and many other hospitality businesses are inherently riskyinvestments because they require specialized management expertise, can be significantlysubject to economic upturns and downturns, and are often not easy to sell rapidly. Thismay be especially true if the business is not operating profitably.

Before individuals, corporations, or other financial entities elect to invest in a business,they will want to know that their investment is a good one. Earnings achieved by aninvestment are typically expressed as a percentage of money earned to money invested.Thus, one way to evaluate the quality or strength of an investment is to measure the returnon investment it generates. Return on investment (ROI) is simply a ratio of the moneymade compared to the money invested. ROI is computed as:

Money earned on funds investedFunds invested

= ROI

This ratio of earnings achieved to investment is critical to determining investmentquality.

To illustrate, consider Gerry Tuskey. Gerry is considering investing $100,000 in the BlueLagoon Water Park. If Gerry is convinced that, on an annual basis, earnings of $15,000would be achieved for each $100,000 invested, the projected ROI would be computed as

$15,000$100,000

= 15% ROI



If, however, Gerry, upon analyzing the Blue Lagoon s income statement, determined that themoney likely to be earned was only 5,000; the resulting ROI would be computed as follows:

$5,000$100,000

= 5% ROI

As a general rule, the higher the ROI sought by an investor, the more risky is theinvestment. It is also true that different investors, with different investment goals, willevaluate and choose from a variety of investment options. All of the choices they make,however, should be designed to help them reach their investment (ROI) objectives.

Investors can choose from a variety of investment options, such as stocks, bonds, metals,and others, each with its own historic record of returns. A partnership of the NationalUrban League, Hispanic College Fund Inc., and the Investment Company InstituteEducation Foundation (as well as other entities) regularly publishes summaries of the ROIachieved by these different investment options. To see them, go to:

www.ici.org/i4s/bro i4s expectations.html

Computing the amount of money that is (or may be) earned on invested fundsrequires a careful reading of a business’s income statement. This is so because theincome statement is the source of the information required to compute ROI. Withoutanalyzing the information found on the income statement, it is not possible to evaluatean investment’s overall attractiveness. For this reason, any informed investor or potentialinvestor in a business will require that the business regularly produce and supply anaccurate and timely income statement. In most cases, this means the production of anincome statement no less than 12 or 13 times (depending upon the length of a business’saccounting period) per year, as well as a fiscal year (see Chapter 2) income statement thatsummarizes the revenue, expense, and net income data for the company’s full operatingyear.

Many restaurant companies have devoted a section of their websites to communicatingwith their investors. They do so by having an ‘‘Investor Relations’’ tab on their sites. Toview two examples of these, check out the websites of Texas Roadhouse Restaurantsand/or Benihana. You can do so by going to:



www.texasroadhouse.com

andwww.benihana.com

When you arrive, click on the ‘‘Investor Relations’’ tab to see the most recent financialcommunication to the investors in these restaurant companies.

Lenders

Most hotel or restaurant acquisitions are financed with both debt (funds lent to a business)and equity (funds supplied by its investors or owners). Those who lend money to a business,in most cases, do so with the intent that the money will be repaid. Lenders to businessesin the hospitality industry include banks, insurance companies, pension funds, and othersimilar capital sources. Lenders may or may not actually own a part of the business in whichthey invest, but they do agree to provide funds for its construction and/or operation.

In actuality, there are essentially two types of entities that lend money to hospitalitybusinesses. The first of these are lenders who simply agree to fund or finance a business.Typically, this is done by granting the business a loan that must be repaid under the specificterms or conditions of the loan. It is important to understand that lenders to a businesshave first claim to the profits generated by the business. As a result, lenders will be repaidbefore a business is permitted to distribute profits to its investors. Because this is so, theROI requirements of lenders are typically lower than those of investors.

Unlike investors who do not actually know what their final ROI will be until thebusiness they invest in summarizes its operational revenue and expenses in an incomestatement, lenders will typically establish the ROI they require before they make a loan.Thus, for example, a bank may elect to lend a business such as the Blue Lagoon WaterPark $1,000,000. The terms of the loan might include the fact that the loan must be repaid,along with 8% interest. This interest rate would represent the ROI sought by the bank’smanagers for their bank’s money.

Additional loan terms would likely include information about how much is to berepaid each month, when the payments are to be made, and any fees the lender charges thebusiness for initiating the loan and supplying the funds. Like investors, lenders seek greaterreturns (higher interest rates) when they perceive the risks of a business not repaying itsloan are high. Alternatively, when a lender believes the risk of default (nonpayment) of aloan is low, interest rates charged for the use of the lender’s funds will be lower also. Todetermine a business’s ability to meet the repayment terms of loans offered to it, a lenderwill want to carefully review the income statements generated by that business.

Creditors

A creditor is a company to whom a business owes money, such as a vendor. Forexample, when Isabella Rosetta, the food and beverage director at the Blue Lagoon, must



purchase food from a vendor, that vendor is likely to extend her credit. As a result,the food ordered by Isabella would be delivered and an invoice detailing the purchasesmade by the Blue Lagoon as well as the cost of the food items purchased would alsobe delivered. The expectation of the vendor, of course, is that the Blue Lagoon wouldpay the vendor for the delivered food according to the credit terms established by thevendor. Until that payment is made, however, the creditor has, for all practical purposes,made a ‘‘loan’’ to the Blue Lagoon equal to the dollar value of the food productsdelivered.

It is important to understand that a business’s vendors must also be profitable.Therefore, it is not surprising to learn that vendors will charge higher prices to thosebusinesses they perceive as having a high risk of invoice nonpayment. Customers withlower risk of nonpayment will often be charged lower prices. As a result, vendors arevery interested in the creditworthiness of their customers. Over the long run, a company’screditworthiness, or the ability to pay bills promptly, is a result of its profitability. Aswe have seen, profitability is measured, in large part, by the information contained in theincome statement. As a result, information from the income statement can be of greatinterest to many of the vendors utilized by a business and may be required before thevendor grants credit to the business.

Managers

Many hospitality managers consider the income statement to be a reflection of theirmanagerial ability. This is so for a variety of reasons. The income statement details howprofitable an operation has been within a designated time period. Excellent managers tend tooperate more profitable facilities than do poorer managers. Thus, in some cases, operationalperformance as measured by the income statement’s results is used to establish managers’raises, compute their bonuses, and in many companies, even determine promotionalopportunities. Because that is true, it is critical that these managers be able to read andunderstand their income statements.

Owners, investors, lenders, and managers are not the only ones interested in the resultsof a business’s income statement. Employees are also important stakeholders in a business.While employees do not typically view the actual income statement of their employer,the information the income statement contains will make a large impact on the potentialstability of their employment. Certainly, if a business is profitable, employees’ jobs are moresecure than if the business is struggling. Similarly, if a business is profitable, employee wagesare more likely to rise, expansion of the business may create additional job opportunities,and employers may have the ability to provide employees with benefit programs that satisfytheir needs as well as those of the business.

For Paige Vincent and all of the other stakeholders in the Blue Lagoon Water Park,understanding how to read and interpret her operational results as reported on theincome statement begins with an understanding of how that income statement is actuallyprepared.



Income Statement PreparationEither because of your own company policy, lender requirements, or simply because it isgood to do so, you will regularly find yourself involved with the preparation or evaluationof income statements. The detail with which these are prepared may vary based upon avariety of factors including the industry in which the business is operated, the sales volumeachieved by the operation, the number of units for which income is reported, and thespecific desires of the business’s owners.

In very small hospitality operations, the owner or managers of the business may beresponsible for the preparation of the income statement. In larger restaurant operations,and especially those in the quick-service restaurant (QSR) industry that includes the greatestnumber of burger, chicken, pizza, coffee, sandwich, and other specialty quick-service-styletake-out units, the manager may simply submit financial data about a store to a centralizedaccounting office. That office would then prepare the unit’s income statement. In very largerestaurants and in many hotels, the income statement may be prepared by professionalswho work onsite.

In all cases, however, as a manager working in the hospitality industry, you mustunderstand the income statement format utilized, as well as how revenue, expenses, andprofits are reported.

It is important to realize that, as the hospitality business changes, so too must theaccounting systems that record its business transactions change. Changes are routine and areto be expected as the hospitality industry continues to evolve and its managers seek to betterrecord their activities and account for their revenues, expenses, and profits. They will changethe format and physical layout (but not the fundamental purpose) of an income statement.

Format

An income statement is designed to identify revenues, expenses, and profits. It is importantto understand that an income statement is a summary of financial information for a definedaccounting period. Thus, hypothetically, and in its very simplest structure, such a statementcould, for example, take the form of Figure 3.1.

In the hospitality industry the physical layout of the actual income statements fordifferent types of businesses will be somewhat different. For example, a restaurant thatserves alcohol would want to identify, on its income statement, the revenue generation andcosts associated with serving drinks. In a family-style pancake restaurant that serves onlyfood and nonalcoholic beverages, the income statement would not, of course, include asection for alcoholic beverages. In a similar manner, at a limited service hotel that generatesits revenue only from room sales, telephone toll calls, and the sale of in-room movies, theincome statement would reflect those revenue (profit) centers. In a full-service resort hotelsuch as the Blue Lagoon, multiple food and beverage outlets and diverse retail profit centerswould be included on the income statement.

Consider the case of Joshua Richards. Joshua owns his own restaurant which is locatedacross the street from the Blue Lagoon. His income statement for this year is presentedin Figure 3.2. The restaurant income statement, using the Uniform System of Accounts for


Income Statement Preparation 71

FIGURE 3.1 Summary of Financial Information

BLUE LAGOON WATER PARK RESORTIncome Statement

For the Period: January 1 through January 31, 2010Revenues $2,100,150Expenses $1,937,976Income (Loss∗) Before Income Taxes $ 162,174

* When an operation’s revenue exceeds its expenses, the amount of theprofits (revenue–expenses) is simply presented on the statement as shownin Figure 3.1. However, negative numbers (losses) on an income statementare designated one of three ways:

1. By a minus (‘‘–’’) sign in front of the number. Thus for example, a $1,000loss would be presented on the statement as −$1,000.

2. By brackets ‘‘( )’’ around the number. Thus for example, a $1,000 loss wouldbe presented on the statement as ($1,000).

3. By the use of the color red (rather than black) to designate the loss amount.Thus for example, a $1,000 loss would be presented on the statement asthe figure ‘‘$1,000,’’ but the number would be printed in red. This approachgives rise to the slang phrase to operate in the red to indicate a businessthat is not making a profit. In a similar vein, to operate in the black wouldindicate the business is profitable.

Restaurants (USAR), shows sales and cost of sales related to food and beverage and anyother expenses related to the functioning of the restaurant.

The USAR can better be understood by dividing it into three sections: gross profit,operating expenses, and nonoperating expenses. Referring to Figure 3.2, the gross profitsection consists of Sales through Total Gross Profit, the operating expenses section coversOperating Expenses through Operating Income, and the nonoperating expenses sectionincludes Interest through Net Income. These three sections are arranged on the incomestatement from most controllable to least controllable by the food service manager. The grossprofit section consists of food and beverage sales and costs that can and should be controlledby the manager on a daily basis. The operating expenses section is also under the control ofthe manager but more so on a weekly or monthly basis (with the exception of wages, whichcan be controlled daily). Consider the Repairs and Maintenance category. Although repairswill be needed when equipment breaks down, maintenance is typically scheduled on amonthly basis. The manager can control, to some extent, how employees use the equipment,but he or she cannot control or predict the breakdown of equipment when it occurs. Thethird section of the USAR is the nonoperating expenses section. It is this section that isleast controllable by the food service manager. Interest paid to creditors for short-term orlong-term debt is due regardless of the ability of the manager to control operations.

Furthermore, taxes are controlled by the government; to paraphrase Benjamin Franklin,the only sure things in life are death and taxes. So, the food service manager has little controlover the amount of money ‘‘Uncle Sam’’ gets every year. Knowing the three sections of



FIGURE 3.2 Restaurant Income Statement

JOSHUA’S RESTAURANTIncome Statement

For the Year Ended December 31, 2010

SALES:Food 2,058,376Beverage 482,830

Total Sales 2,541,206

COST OF SALES:Food 767,443Beverage 96,566

Total Cost of Sales 864,009

GROSS PROFIT:Food 1,290,933Beverage 386,264

Total Gross Profit 1,677,197

OPERATING EXPENSES:Salaries and Wages 714,079Employee Benefits 111,813Direct Operating Expenses 132,143Music and Entertainment 7,624Marketing 63,530Utility Services 88,942Repairs and Maintenance 35,577Administrative and General 71,154Occupancy 120,000Depreciation 55,907

Total Operating Expenses 1,400,769Operating Income 276,428Interest 84,889Income Before Income Taxes 191,539Income Taxes 76,616Net Income 114,923

Prepared using USAR

the income statement allows you to focus on those things over which you have the mostcontrol as a manager.

Note also, the differences in presentation format between the restaurant incomestatement, and Figures 3.3 and 3.4; the January income statements for the Blue LagoonResort (hotel format). Figures 3.3 and 3.4 show two alternative formats for a hotel incomestatement using the Uniform System of Accounts for the Lodging Industry (USALI).



FIGURE 3.3 Hotel Income Statement—Vertical Format


For the Period: January 1 through January 31, 2010

Total Revenue 2,100,150Rooms—Revenue 1,200,000

Payroll and Related Expenses 247,200Other Expenses 105,900Department Income 846,900

Food—Revenue 600,000Cost of Sales 178,200Payroll and Related Expenses 182,400Other Expenses 44,400Department Income 195,000

Beverage—Revenue 240,000Cost of Sales 37,620Payroll and Related Expenses 44,580Other Expenses 16,800Department Income 141,000

Telecommunications—Revenue 6,000Cost of Sales 14,100Payroll and Related Expenses 4,500Other Expenses 2,400Department Income –15,000

Other Operated Departments—Revenue 45,000Cost of Sales 6,600Payroll and Related Expenses 15,000Other Expenses 5,400Department Income 18,000

Rentals and Other Income—Revenue 9,150Cost of Sales 1,320Payroll and Related Expenses 4,080Other Expenses 900Department Income 2,850

Total Operated Department Income 1,188,750

Undistributed Operating ExpensesAdministrative and General 113,100Information Systems 29,700Human Resources 48,600Security 23,100Franchise Fees 0Transportation 27,900

(Continued)



FIGURE 3.3 (Continued)

Marketing 129,360Property Operations and Maintenance 99,750Utility Costs 89,250Total Undistributed Operating Expenses 560,760

Gross Operating Profit 627,990

Rent, Property Taxes, and Insurance 146,700Depreciation and Amortization 105,000

Net Operating Income 376,290

Interest 106,000

Income Before Income Taxes 270,290

Income Taxes 108,116

Net Income 162,174

Prepared using USALI

The USALI can better be understood by dividing it into three sections: operateddepartment income, undistributed operating expenses, and nonoperating expenses. Refer-ring to Figures 3.3 and 3.4, the operated department income section consists of separateprofit centers as department income. As you can see in these particular statements,department income is generated by rooms, food, beverage, telecommunications, otherdepartments, and rental and other income. Each of these departments report revenues,expenses, and income generated by the department. The undistributed operating expensessection covers Undistributed Operating Expenses through Gross Operating Profit. Thissection includes expenses that cannot truly be assigned to one specific department, andare thus not distributed to the departments. Examples of these expenses are security,transportation, and franchise fees. The nonoperating expenses section includes Rent,Property Taxes, and Insurance through Net Income. This section includes items suchas rent, depreciation, interest, and income taxes, and is least controllable by the hotelmanager.

It is important to note here that depreciation expense (see Chapter 2) in all formsof the income statement serves a very specific purpose. Depreciation is subtracted fromthe income statement primarily to lower income, thus lower taxes. The portion of assetsdepreciated each year is considered ‘‘tax deductible’’ because it is subtracted on the incomestatement before taxes are calculated.

Figure 3.3 shows the operated department income vertically and Figure 3.4 shows theoperated department income horizontally. Either format used by individual hotels is amatter of preference.



FIGURE 3.4 Hotel Income Statement—Horizontal Format


For the Period: January 1 through January 31, 2010

Payrolland

Net Cost of Related Other IncomeRevenue Sales Expenses Expenses (Loss)

Operated DepartmentsRooms 1,200,000 0 247,200 105,900 846,900Food 600,000 178,200 182,400 44,400 195,000Beverage 240,000 37,620 44,580 16,800 141,000Telecommunications 6,000 14,100 4,500 2,400 (15,000)Other Operated Departments 45,000 6,600 15,000 5,400 18,000Rentals and Other Income 9,150 1,320 4,080 900 2,850

Total Operated Departments 2,100,150 237,840 497,760 175,800 1,188,750

Undistributed Operating ExpensesAdministrative and General 76,800 36,300 113,100Information Systems 12,000 17,700 29,700Human Resources 43,800 4,800 48,600Security 16,620 6,480 23,100Franchise Fees 0 0 0Transportation 4,200 23,700 27,900Marketing 64,320 65,040 129,360Property Operations and Maintenance 24,300 75,450 99,750Utility Costs 0 89,250 89,250

Total Undistributed OperatingExpenses 242,040 318,720 560,760

Gross Operating Profit 2,100,150 237,840 739,800 494,520 627,990

Rent, Property Taxes, and Insurance 146,700Depreciation and Amortization 105,000

Net Operating Income 376,290

Interest 106,000

Income Before Income Taxes 270,290

Income Taxes 108,116

Net Income 162,174

Prepared using USALI



In the remaining portions of this chapter, we will often use data from the Blue Lagoonand other hospitality operations to learn more about collecting and analyzing revenueand expense data, as well as operational profits. We’ll be referring to these sample incomestatements later when we illustrate the various formulas in this chapter.

While the layout of a business’s income statement will vary somewhat based uponthe Uniform System of Accounts applicable to its industry segment, there are basiccommonalities among income statements that you should know about and understand.In general, the process of preparing an income statement for a business consists of thefollowing three steps:

1. Identification of accounting period2. Documentation of revenue data3. Documentation of expense data

Accounting Period

In Chapter 2 you learned that the period of time (the specific number of days and dates)included in a summary of financial information is called an accounting period. Theseaccounting periods are established by management and should make sense for the businessto which they are applied. For many businesses, the accounting periods established coincidewith the calendar months of the year. Thus, for example, at the Blue Lagoon Water Park,12 monthly income statements are produced, each consisting of the data produced duringits respective month.

Many (but not all) businesses choose this alternative because it eases the company’sability to file annual tax returns, most of which are due based upon the calendar year. Insome cases, businesses prefer to create income statements that are 28 days long. When theydo so, it is because these managers seek to create perfectly ‘‘equal’’ accounting periods.Thus, in this system, each period is equal in length, and has the same number of Mondays,Tuesdays, Wednesdays, and so forth. This helps the manager compare performance fromone period to the next without having to compensate for ‘‘extra days’’ in any one period.Additional advantages of the 28-day approach will be clear when you learn more about theanalysis of income statements.

Businesses may also elect to create income statements bi-monthly, quarterly, or evenannually. Figure 3.5 summarizes the most popular lengths of time used by hospitalitymanagers and accountants when they create income statements.

In some cases, the managers of a business who choose to utilize longer account-ing periods may also be interested in ‘‘mini’’ income statements that detail speciallyselected revenue and expense categories on a shorter-term basis. These may take theform of weekly, daily, or even hourly financial summary reports. In all but the mostunusual circumstances, however, these documents would lack the specific and accuraterevenue and (especially) the expense data required to produce an income statement whichmeets the standards considered necessary for incorporating generally accepted accountingprinciples.



FIGURE 3.5 Common Income Statement Accounting Periods

Accounting Period Number of Days Included

Month VariesQuarter VariesAnnual 365 days (except leap year)28-day 28 daysWeekly 7 daysDaily 1 day

Regardless of the income statement time period chosen by management, it is importantthat this period be clearly indicated at the top of the prepared income statement document.This is done to ensure that the document’s readers know, before they begin reading, exactlywhen the financial period which is being reported upon actually began and ended.

Figure 3.3 is an example of the income statement title heading used at the Blue LagoonWater Park. It is easy to see from this figure that the Blue Lagoon’s management has electedto create monthly income statements based upon a calendar month.

Revenue Data

After the inclusion of the document’s title and the clear identification of the dates included,the first portion of the income statement details the revenue data to be reported during theidentified accounting period. On some businesses’ income statements the terms, ‘‘sales,’’‘‘revenue,’’ or a combination (i.e., ‘‘sales revenue’’) may be used; but in all cases theterm used should represent the revenue generated during the accounting period by thatbusiness’s normal business activity.

In many businesses, revenue listed on the income statement will come from more thanone source. Managers of these businesses will likely want to know the relative contributionof each source. In Figure 3.3, the Blue Lagoon shows that it generates revenue from sixdistinct sources: rooms, food, beverage, telecommunications, other operated departments,and rentals and other income.

In a large resort hotel, there might literally be dozens of actual sources of revenue. Thus,they are frequently listed by managers using the procedures recommended by the UniformSystem of Accounts for the Lodging Industry (USALI). Currently, the USALI suggests thatmanagerial accountants in the hotel industry use one or more of the following categoriesto record their hotel’s revenues:

� Rooms� Food� Beverage� Telecommunications� Garage and Parking� Golf Course



� Golf Pro Shop� Guest Laundry� Health Center� Swimming Pool� Tennis� Tennis Pro Shop� Other Operated Departments� Rentals and Other Income

Of course, hotels with special revenue-generating features may wish to add additionalrevenue reporting sections to record that special-feature revenue on their income state-ments. It is also important to understand that a large resort may have multiple restaurantand bar outlets, several types of retail stores, and many in-room amenities options suchas telephone toll charges, purchases from mini-bars, pay-per-view movies, and laundryservices. Additional revenue sources could include services such as those for valet parking,activities such as video arcade revenue and spa services, as well as the rental of motorizedand un-motorized sports equipment. Regardless of its source, all revenue should be clearlyreported on the income statement.

On the other extreme, a hospitality operation may simply have one source of revenues.This could be the case, for example, in a retail bakery shop that sold only high-quality,fresh baked breads. Even in this situation, however, the bakery’s owner may want tocreate sub-categories of revenues to better understand exactly where the bakery’s revenueis generated. For example, these might include sub-sections based upon the style of breadproduced, (i.e., French, Italian, Sourdough, and the like), the type of flavorings used,(i.e., cheeses, seeds, herbs, etc.), or even the size of loaf (1/2 loaf, 1 pound, 2 pound,etc.).

As a manager in the hospitality industry, it will be an important part of your job toensure that the revenue sources identified on the income statements for which you areresponsible include all of the revenue that is to be reported and that this revenue is groupedin such a way as to be meaningful to the statement’s readers. It is for this reason that manyoperators adopt the income statement format utilized by the uniform systems of accountsfor their specific industry segment.

Expense Data

As shown in Figure 3.1, following the title, accounting period, and revenue of the incomestatement is the section reserved for identifying the expenses incurred by the business.

There are two major issues with which managerial accountants must concern themselveswhen they consider the expense data included on their income statements. As a result,before we examine actual expense categories utilized on an income statement, these issuesmust be well-understood. The issues are the timing and the classification or placement ofthe expense.



Expense TimingJust as Paige Vincent must ensure that all of the revenue generated by the Blue LagoonWater Park in a specific period is accounted for, so too must she make sure that all of therelated expenses incurred by the resort have been included in the preparation of her incomestatement. That is, Paige must make sure that she has included all of the January period’sexpenses required to generate the revenue reported on the January income statement. Notto do so would understate expenses and, (because of the formula used to compute profits)overstate profit. Alternatively, to intentionally (or even unintentionally) overstate expensesand thus include some expenses that were not, in fact, truly incurred, would have the effectof understating profits.

Recall from Chapter 2 that accrual accounting requires a business’s revenue to bereported when earned and its expenses to be recorded when incurred. This matchingprinciple is designed to closely tie expenses of a business to the actual revenues thoseexpenses helped the business generate. While matching expenses to revenue might, atfirst examination, seem to be a very simple process, in actuality managerial accountantsare continually called upon to make important decisions when they determine theappropriateness of which specific expenses to include on an income statement.

Decisions made about how best to match revenues to expenses can be complex andeven open to honest difference of opinion among hospitality managers. These decisionswill be established by generally accepted accounting principles, by company policy, byproperty-specific policy, or in some cases, the best decision that can be made by theperson(s) preparing the income statement. To see why this is so, consider a samplingof some of the decisions Paige and the managerial accountants working with her mustmake when they establish the expenses incurred by the Blue Lagoon during the Januaryaccounting period for which they are now preparing an income statement. Note that thefollowing six scenarios are only examples of the types of questions Paige may encounter,and thus, you are not expected to know the answers to these. Paige would have to gatherand analyze more information than is provided in this chapter to formulate decisions basedon these questions.

1. Paige pays local property taxes on the Blue Lagoon twice per year. One half of thebill is due in February and the remaining balance is due (six months later) in August.For the January portion of the property tax expense, should she enter:

� 1/12 of the annual bill?

� 31/365 of the annual bill?

� ‘‘$0.00,’’ because she did not pay property tax in the month of January?

2. In the month of January, the Blue Lagoon spent $10,000 on produce purchasedfrom a local vendor. The resort also received an invoice credit (refund) in Januaryfor $200 for some produce delivered to the kitchen in late December of the previousyear (and thus the original cost of the products was included in the cost of Decemberfood purchased), but which was later found to be of inferior quality. The result of a



subsequent discussion between Paige’s food and beverage director and the vendorwas a decision by the vendor to issue the $200 credit. For January, should Paige’sproduce expense be computed as:

� $10,000?

� $10,000 − $200 = $9,800?

3. The Blue Lagoon pays its employees every two weeks. On January 17 it paid itsemployees for the time period December 29 through January 11. Because the entiretwo-week period was paid in January, should Paige count the entire cost of thepayroll as a January expense, or only 11/14 of the payroll (to reflect the 11 actualdays in January for which the workers were paid?

4. On January 2, Paige paid the entire premium for the resort’s annual liquor liabilityinsurance policy. The premium cost was in excess of $10,000. Should Paige attributethis entire expense to the month of January, or only 1/12 of the entire amount?

5. On January 22, the housekeeping department purchased 12 rubber vacuum cleanerdrive belts. The total cost of the belts was less than $20. It is expected that this supplyof belts will last the hotel for three months. Should the cost of the belts:

� Be charged entirely as a January expense?

� Be expensed in the month they are actually installed on the vacuums?

� Be expensed as they (the new belts) break and thus must be replaced?

6. On the twentieth day of each month, Paige receives the resort’s monthly water bill.The bill received in the month is for water used in the prior month. As a result, onJanuary 20, Paige receives December’s water usage bill. Should this be considered a‘‘January’’ expense, or should Paige delay the production of her property’s incomestatement until February 20 (at which time she would be able to include the actualcharges for January’s water usage)?

Recall that the consistency principle of accounting requires managers to be uniform indecision making. That is, if an expense is treated in a specific manner in one instance, itshould be treated in an identical manner in all subsequent situations. Additional factors thatmay influence decisions regarding the recording of expenses include rules and regulationsenforced by taxing authorities and other governmental agencies.

Expense ClassificationMost managers want to be able to use their income statements to help them bettermanage their operations. To ensure that the income statement is as helpful as possible,these managers ensure that expenses are carefully and consistently classified by thosewho are preparing the statements. To see why this is so important, carefully consider theoperated departments’ payroll expense summaries that are generated by the Blue Lagoon’smanagerial accountants in Figure 3.6.



FIGURE 3.6 Operated Departments’ Payroll and Related Expense Summaries

Option 1 (With no detailed classification)

BLUE LAGOON WATER PARK RESORTOperated Departments’ Total Payroll and Related Expenses: January 2010

Payroll and Related Expenses $497,760

Option 2 (With department-specific detailed classification)

BLUE LAGOON WATER PARK RESORTOperated Departments’ Total Payroll and Related Expenses: January 2010

DepartmentRooms $247,200Food 182,400Beverage 44,580Telecommunications 4,500Other Operated Departments 15,000Rentals and Other Income 4,080Total Operated Departments $497,760

The payroll summaries presented in Options 1 and 2 are both accurate because theypresent the same data. It is easy to see, however, that the data as presented in Option 2will very likely provide the Blue Lagoon’s management team with better informationabout how payroll dollars are actually being utilized in the operated departments of theresort.

Expense classification is the process of carefully considering how a business’s expenseswill be detailed for reporting purposes. Earlier in this chapter you learned that manymanagers consider each individual revenue-generating segment within their overall businessto be its own profit center. As a result these managers may seek to place (assign) to eachdepartment or profit center the expense that center utilized to generate its revenue. Thesemanagers concern themselves not merely with the proper timing of expenses; they areequally concerned about the placement of the expense as well.

In some cases, the proper placement of an expense is very straightforward. Forexample, the purchase of a case of Chardonnay used during a wedding reception will clearlybe classified as a beverage expense in the beverage department’s portion of an incomestatement. In a similar manner, the purchase and use of electronic key cards created forguest use can easily be classified as a front desk expense within the overall expense reportingof a hotel. Chlorine purchased for use in a swimming pool can easily be consideredan expense in the maintenance and operation portion of a water park’s total operatingexpenses.



In a small operation, costs may be easy to classify. In a larger operation with multipleprofit centers, operating expenses may be harder to classify. Consider, for example, thecosts related to advertising and marketing the Blue Lagoon. In this case, each dollar spenton promotion will likely have some impact on each of the resort’s profit centers. It wouldlikely be difficult to determine, however, the proportional amount of the advertising costthat should be pro-rated to each of the resort’s rooms, food, beverage, or retail sales outlets.In a similar manner, items such as property taxes may also be difficult to assign to a specificdepartment or profit center. Even payroll costs in a resort such as the Blue Lagoon can bedifficult to classify. For example, it is easy to see that a front desk agent’s payroll costs shouldbe assigned to the hotel’s rooms department. It is less easy to determine how the chef’spayroll costs should be allocated between the resort’s restaurant and the cocktail lounge,where recipes and production procedures for appetizers and snack items are developed.Even more difficult to pro-rate accurately would be an item such as the salary of the resort’sgeneral manager.

In the hotel industry, when an expense is easily attributable to one department, it isclassified as a departmental cost. This type of cost is sometimes referred to as a directoperating expense. As you learned earlier in this chapter, when the expense cannot trulybe assigned to one specific area within an operation, it is classified as an undistributedoperating expense. The current version of the USALI, for example, suggests that thefollowing categories be considered as undistributed operating expenses:

Administrative and GeneralInformation SystemsHuman ResourcesSecurityFranchise FeesTransportationMarketingProperty Operations and MaintenanceUtility Costs

As you have learned, it is important that managerial accountants understand the issuesrelated to timing and classification of their expenses when preparing income statements.While it is not, in most cases, a legal requirement that a hospitality operation use a specificmethod for timing and classifying expenses, many restaurateurs and hoteliers use, or advisetheir accountants to use, the uniform system of accounts (see Chapter 3) established fortheir own segment of the hospitality industry. It is important to understand that theuniform systems of accounts for any segment of the hospitality industry are constantlyevolving as new accounting challenges are encountered. Thus, it is not unusual to encountertwo managerial accountants who utilize the uniform systems slightly differently to bestaddress the issues of their own businesses. In the remainder of this text, we will, in mostcases, utilize these uniform systems to present and illustrate the information you willlearn.



FIGURE 3.7 Income Statement with Revenue Schedules Identified


For the Period: January 1 through January 31, 2010Revenues:

Rooms (Schedule 1) $1,200,000Food (Schedule 2) $ 600,000Beverage (Schedule 3) $ 240,000Telecommunications (Schedule 4) $ 6,000Other Operated Departments (Schedule 5) $ 45,000Rentals and Other Income (Schedule 6) $ 9,150Total Revenues $2,100,150

Expenses $1,937,976

Income (Loss) Before Income Taxes $ 162,174

Schedules

Thus far we have concerned ourselves with the examination of income statement summaries.In addition to summaries, managerial accountants may use one or more departmentalschedules to provide statement readers with more in-depth information about importantareas of revenues and expenses. These schedules provide the reader detail where thestatement preparer feels it is useful to do so. As a result, the revenue or expense portionof an income statement could consist of only one line or several sources. As shownin Figure 3.7, it may consist of a summary with reference to one or more departmentalschedules that will provide additional detail.

In the previous chapter, you learned about the Uniform System of Accounts forRestaurants (USAR), the lodging industry (USALI), and clubs (USFRC). The methodsmanagerial accountants in those industries use to create appropriate schedules are importantareas addressed by these uniform systems. It is essential to recognize, however, that managersshould always strive to use the specific methods of reporting that best maximize and clarifythe information provided to the statement’s readers. Information about how much revenueand costs a business generates is critical to many of a statement’s readers, thus it should bepresented clearly, honestly, and in keeping with generally accepted accounting principles(see Chapter 2). Not to do so is not only dishonest and unethical; in some situations it mayalso be illegal!

It is important to realize that schedules should be created to help readers betterunderstand the income statement they are reading. To see how that is done, considerthe information in Figure 3.8, a portion of the rooms department schedule for the BlueLagoon. After reviewing the data, it should be easy for you to see that the Blue Lagoon’smanagement will simply know and understand more about the specific sources of the



FIGURE 3.8 Rooms Department Revenue Schedule

BLUE LAGOON WATER PARK RESORTSchedule 1: Rooms Department Revenue

For the Period: January 1 through January 31, 2010Rooms Revenue:

Transient Leisure $ 600,000Group Leisure $ 390,000Transient Package $ 150,000Group Package $ 60,000Total $1,200,000

resort’s revenues if they examine the schedule in Figure 3.8 than if the only rooms revenueinformation available for examination was that which was listed in Figure 3.3.

Note that, in this case, the management of the Blue Lagoon has elected to tell readers ofits income statement about the relative revenues provided by those guests who are transient(individual) leisure travelers, group leisure travelers, transient guests who purchased aspecially packaged collection of goods and services (a package), and those individual guestswho purchased their package as part of a larger group.

Hotels of various types will provide readers of their financial statements the mostinformation if they create schedules geared for their specific operation. Thus, for example,a hotel located near an airport may determine that it is best to create revenue schedulesthat identify corporate versus leisure travelers. An all-suite hotel property may determinethat it is best to create revenue schedules based upon those guests who are transient versusthose who are considered extended stay guests. Because it is important for those in chargeof marketing to direct their marketing efforts to specific guest types, many rooms managersin the industry frequently use one or more of the following segments to classify guests andthus the revenues they generate:

Transient (Individual)CorporateLeisureDiscountPackageLong-term stay

GroupCorporateLeisureDiscountPackageAssociation



Tour busAirline crewSocial, Military, Education, Religious, Fraternal (SMERF)Other

As a manager working in the hotel industry, you can assist your property the most byensuring the rooms revenue schedules you help create or interpret are geared as specificallyas possible to your own property. In the food and beverage revenue area, revenue schedulesmay be created based upon the sales achieved by individual restaurants and bars withinthe hotel, guest types, or even hours of operation. The purpose of each revenue orexpense schedule created, however, should be that of enhancing and clarifying readers’understanding of the income statement.

Because your entire career may take you into many segments of the hospitality industry,it is more critical for you to understand the principles behind the preparation of an incomestatement than the current format of any specific business’s income statement. In this text,we will present several formats, each of which may be useful if you follow the principles ofincome statement preparation presented in Figure 3.9.

Several software developers produce products that can help managerial accountantsprepare their own income statements. One of the most popular is Intuit. To view theirproduct offerings, go to:

www.intuit.com

When you arrive, click on ‘‘Business Management’’ to review QuickBooks; aninexpensive accounting product that can easily be utilized by smaller restaurants andlodging facilities.

FIGURE 3.9 Principles of Income Statement Preparation

A properly prepared income statement:

1. Clearly identifies the business whose revenues and expenses are being summarized.2. Plainly states the specific accounting period for which the statement has been prepared.3. Includes a summary, in the most informative (detailed) manner practical, of all the revenue generated

by the business during the accounting period.4. Summarizes all accounting period expenses utilized by the business to generate the stated revenue.5. Utilizes a logical and consistent system to classify expenses.6. Provides additional clarity via the use of schedules where appropriate.7. Incorporates the use of a uniform system of accounts if applicable.



Income Statement AnalysisIncome statements summarize data. Managers analyze that data because they rely on theirincome statements to help them better understand and thus better manage, their business.As you read the following questions, consider why the answers to these would be of interestto the resort’s owners, investors, lenders, and managers.

� What was the resort’s total revenue for the period?� How much profit was made during the period?� Was more or less money made than was made in the same period last year?� Did the resort make the amount of profit it was expected to make? If not, why not?� In what areas of the resort were costs higher (or lower) than expected?� Which areas of the resort require extra attention from management to ensure that

they are operating according to management’s plan?� Did the resort’s operational performance meet the financial expectations of its

owners and managers? If not, in which departments or areas did it fall short? Inwhich departments or areas did it exceed expectations?

Depending on their roles, the owners, investors, lenders, and managers may placedifferent importance on the answers to these questions. You as a manager, however, willbe primarily interested in the revenues, expenses, and profits over which you will haveprimary control.

Because the income statement is naturally divided into three main parts, it is thosesame three parts that make up the areas of analysis important to managers. Because younow understand how an income statement is developed, in the next sections of this text,you will learn about how managers use the income statement to examine and evaluate:

RevenueExpensesProfit

Revenue Analysis

Managers are concerned about revenue levels in a business because it is one very importantmeasure of guest satisfaction. In most cases, expenses for a business will go up continually.Employees will get raises, in most cases products and services used by the business will tendto increase (not decrease) in price, and items such as taxes and insurance tend to cost abusiness more each year than they did the year before. In the face of these types of risingcosts, you must normally increase your revenue levels if you hope to maintain or increasethe amount of profit made by your business.

If the owners and managers of a restaurant seek to increase revenue, they must doso by:


Income Statement Analysis 87

1. Increasing the number of guests served, and/or2. Increasing the average amount spent by each guest.

If a manager determines that his revenue has declined from previous periods, it maybe that fewer people are coming to his restaurant, or those who do come are spending lesseach time they frequent the business.

In the hotel business, if management seeks to increase its rooms revenue, it must doso by:

1. Increasing the number of rooms sold, and/or2. Increasing the average daily rate (ADR) for the rooms it sells.

If revenue has declined from previous periods, it will be that fewer rooms have beensold, or that those rooms sold were sold at a lower ADR.

A careful analysis of revenue in a restaurant or hotel involves more than simplyidentifying the total amount of sales. Consider Lars and Cheryl, two hotel managers, whoeach state that the sales in their respective hotels last month were $200,000. The two hotelswould appear to be ‘‘equal’’ until you realize that Lars’ hotel has 300 rooms and Cheryl’shas 150. Now the $200,000 revenue generation takes on new meaning and the hotels do notappear nearly as equal. In a similar manner, consider Tamara, a restaurateur, who statesthat sales in her sub shop this February were $50,000. The revenue number by itself ishelpful, but it would be more helpful to compare the $50,000 sales to the sales volume sheachieved the prior February. Consider the information in Figure 3.10 and you will easilysee that a revenue performance of $50,000 could be viewed quite differently based uponthe restaurant’s prior performance.

In most cases, managers are concerned about the sources and total amount of sales orrevenue their businesses have achieved, but they should also be interested in the changes(increases or decreases) to revenue experienced by their businesses. Increases in revenue,for example, may be tied to increased numbers of guests served, expansion of products andservices sold, an increase in the number of hours the business is operated, or changes inthe prices charged. Declines in revenue could indicate reduced numbers of guests served,reduced spending on the part of each guest served, or any number of a variety of otherexplanations that should be known by management.

FIGURE 3.10 Revenue Comparisons

Tamara’s Sub Shop Restaurant

Revenue for February

Revenue Last February Revenue This February Conclusion1. $50,000 $50,000 Equal sales

2. $75,000 $50,000 Declining sales3. $25,000 $50,000 Increasing sales


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